Oil: when does good news become bad?

What does the excess of oil tell you?  Source: Google Images

What does the excess of oil tell you? Source: Google Images

Continued crash in oil prices, with WTI breaking through stops at $47 to reach another low:

We're awash in oil!  Source: thinkorswim by TDAmeritrade

We’re awash in oil! Source: thinkorswim by TDAmeritrade

The recent press (e.g. here and here) is getting ambivalent, in my opinion.  What was once a definite ‘good thing’ for the world, and the US consumer, has now become a ‘well, let’s think about this’ as the price has continued to fall.  In particular:

  • Who’s definitely worse off: our usual villains, such as Russia, Venezuela, Iran, etc.
  • Who’s definitely better off: emerging economies which are big oil importers, such as India, Philippines, China.
  • Who was definitely better off, but maybe not so much anymore: developed countries.  Why?
    • The consumer: Joe Bloggs is definitely better off at the gas pump, and maybe for purchased goods as well (e.g. transportation and manufacturing costs are lower).  For those in the US in particular, the strong dollar is an added bonus for the consumer.
    • The producer: Company ABC might be better off, depending on its relative dependence on energy.  For the airlines and shippers, as well as SUV producers, the lower oil price is a god-send.  For exporters, transit costs are lower, so should be helped.  However, a strong USD is bad for exporters, as well as multinational corporations with much sales overseas.  Worst of all are the oil companies themselves, obviously; some of these (more debt-laden, shale players) will likely go bankrupt.
    • The employee: decreasing oil prices lead to lower inflation, which means higher real wages for employees.  Thus, they should be happier – if they still have a job.  All those new jobs created in North Dakota and elsewhere, based on now-uneconomic shale oil/gas, are likely at-risk.
    • The investor/pension-holder: hmm – what to do?  Much has been written that oil/gas companies are HUGE providers of capital expenditure (thus needing investment, and paying returns) and dividends (helping those pensioners).  All of that is at risk now, with share prices falling accordingly.  All of the items above need to be in the investor’s mind as well – strong USD; better global growth prospects, particularly in emerging economies (partially offset by the USD); generally better news for developed countries, though maybe not too good.

In sum: while the falling oil price was once universally cheered by Western media, the news has become more mixed as ramifications of much lower oil prices are digested.

If only things were more black and white, eh?

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Let there be…vol?

Will there be calm, or more party time?  Source: Google images

Will there be calm, or more party time? Source: Google Images

So this is probably the last ‘serious’ week for financial markets of 2014.  Some thoughts:

  1. Is oil done?  The news seems more bent on $40/barrel oil, or at least $50, so another 10-15% down move from here.  I’m sure many recognise that the media is generally way late to the party, so perhaps today’s slight recovery to above $58 is putting in the near-term floor.  My momentum models don’t care about the debate, and are staying well-short.
  2. Which is right: VIX or S&P?  Last week’s rise in the VIX, from about $12 to about $19, was an outlier move – similar to what happened last October.  So are we due for an exciting, proper sell-off in the S&P?  Or is this morning’s resilience in the index (up about 1%), combined with VIX selling off (down about 3%), the more relevant fact?  On Friday I reloaded on my old favourite UVXY trade, so I’m clearly hoping the latter.
  3. I feel bad for being long grains.  My same momentum models have me long soybeans, which has been a pretty good trade so far.  However I can’t ignore the oversupply, which I hear from family in the Midwest.  Another example of how the biggest enemy to a systematic trading approach is probably manual intervention.

In sum: I’d like a quiet week.  My models would prefer a chaotic week – or at least a continuation of that lovely oil trend.  With the remaining economic news of 2014 released this week, combined with rolls/option expiry, I’m guessing there will still be plenty of action.

From Cournot to Bertrand equilibria: OPEC giving discounts

Dusting off my old economics lessons, I recognised a couple concepts from today’s Bloomberg article on Iraq joining Saudi Arabia in giving oil price discounts.

In particular, oligopoly behaviour can frequently be modelled by quantity-based competition (Cournot, and old OPEC) or by price-based competition (Bertrand, and what we see today in OPEC).  The key point, as this Brown University lecture note states very well, is:

We conclude that in a Bertrand equilibrium, in the homogeneous good case, under the assumptions we have made, firms 1 and 2 will charge the same price, and the price will be equal to marginal cost. But this means that the duopoly market, in the Bertrand model with a homogeneous good, looks just like a competitive market. In particular, there is no inefficiency (no loss of social surplus) in the duopoly market. 

So go ahead and call up your local OPEC representative and thank him/her for providing a market-clearing, maximum efficiency price for oil consumers.  WTI oil has broken $63/barrel recently, which surely means $1.75/gallon gas for US drivers at some point??

Another leg down for oil

Youch:

OPEC to Putin: no sympathy.  Source: Amibroker.

OPEC to Putin: no sympathy. Source: Amibroker.

Looks like prices at the pump have nowhere to go but down.  Thanks to typical Cournot competition resulting from lack of collusion, all the OPEC players lose.

Not even Qatar will like WTI below $71, or Brent below $75:

Agreeing to disagree = no one happy.  Source: BBC News

Agreeing to disagree = no one happy. Source: BBC News

Update: as WTI took out stops @ 69.50, nearly kissing the 69 level, we’re now kinda below the territory the pundits mentioned oil would go without an OPEC cut.  A couple thoughts:

  • Wow.  Oil falls fast.
  • Unlike the moves in several other commodities, I’m not convinced this oil move is principally a strong-USD bet.  I think it’s mainly just a way-oversupplied oil market with lots of players who can’t feasibly stop producing.  The countries need even the discounted revenue to maintain budgets and services.  So, for oil-consumers, this is about as close to ‘Happy Christmas from the Middle East’ as we’re going to get.

Anyone for oil?? Anyone?? Bueller?

So the stock and bond markets are yawn-worthy these days.  What’s a trader to do?  Clearly, it’s time to sell oil:

Excuse me, your oil is leaking.  Source: thinkorswim by TDAmeritrade.

Excuse me, your oil is leaking. Source: thinkorswim by TDAmeritrade.

WTI crude is down about 25% from mid-year highs.  Since end-Sep, there has been a pretty much straight-line fall of around $20.

A lot of headlines can, have, and will be written about this fact.  Among the themes I’ve already seen:

  • Russia is doomed, as are a lot of EM countries which rely on high oil prices to sustain government spending.
  • US shale oil is doomed, as break-evens for these wells is around $75.  That’s the end of a great run in job creation, US oil self-sufficiency, etc. etc.
  • Global industrial production will get a nice lift from cheaper energy prices.
  • Global inflation will have a big drag.  Probably not exactly what the world needs, with inflation at or near zero in much of the developed world.

And some more of my thoughts, which I haven’t read other places (yet).

  • Alternative energy, particularly electric cars, will face a big headwind as Americans see sustained gas prices < $3.
  • Remember Scotland’s referendum, which relied on oil revenues to handle the gap in government spending?  They assumed $110/barrel.  So they would already be about 30% in the hole.  Ouch.
  • Systematic trading is a great way to take advantage of these types of moves.  I’m pretty sure there aren’t many fundamentals guys staying short oil at this level (or likely remained short at the $80 or $75 level).  Momentum strategies would still be short.
  • Tying together my previous posts on the subject:

In sum, thanks to the oil price for keeping markets lively the past week or so.

No one likes commodities anymore

A prime example of why I don’t favour long-commodities in the portfolio: I don’t understand how/why they can fall, seemingly forever, on well-known economic themes.

Grains had it bad for most the year, but oil caught up.  Here are 2 long-only ETF/ETNs showing the issue: USO follows the oil price, and CORN follows the corn price.

Screen Shot 2014-11-04 at 13.30.48

One characteristic that has been nice is sustained trends.  That means medium-term momentum funds have made a killing on these products this year.  A small pat on the back for inclusion of the managed futures mutual fund.

In other news, the equity markets seem to be rattled again – just a couple days after the JCB adding a ton of stimulus, and GPIF buying a new $180bn in equities.  Maybe back to proper two-sided markets??